Many people think that as they get closer to retirement, they should have a higher percentage of bonds in their portfolio. This is because bonds have traditionally been considered a “lower risk” type of investment. They typically do not have as much price movement as stocks do and as long as you invest in high quality bonds, you are likely (if not promised – in the case of government treasuries) to get your money back if you hold them to the end of their term. This makes people feel like they “can’t lose money” with bonds. But as we’ve seen in 2022, you actually can lose money with bonds. The Total Bond Index lost 13%. This is because bonds are a terrible investment to have in a high inflation economy. Why? For 2 reasons:
- Mathematically, when interest rates rise, bond prices fall. They have an inverse relationship. This might not be a big deal to you if you plan on holding your bond to maturity (which could be years or decades down the line), but if you want to sell your bond, or if you hold bond mutual funds, this is bad news. The Fed will continue to raise interest rates until inflation slows down and bond prices will continue to fall accordingly. This is not just a market prediction – it is a literal mathematical concept.
- Bonds pay a fixed interest rate. As inflation goes up, the fixed interest payment does not. Additionally, if you plan on holding your bond until maturity – at which time your principal is paid back to you, that money is going to have less buying power when you get it back than it was when you purchased the bond, due to inflation. So you may get back the same dollar amount you paid, but you won't be able to buy nearly as much stuff with it.
Stocks, on the other hand, while they may have more price movement, have provided much better average returns over time than bonds, cash, or gold. Take a look at the below chart, which shows the AFTER inflation average returns (AKA “real returns”) of different asset classes since 1970. Stocks (the top two) blow everything else out of the water.
Setting aside today’s economic conditions, let’s talk about why most retirees should be invested in stocks in general. The average withdrawal a retiree makes from their investments ends up being around 4-5% of their portfolio annually. This has been traditionally recognized as a “safe” withdrawal percentage, but also assumes the underlying investments are growing enough over time to make sure you don’t run out of money. If bonds on average only return less than 3% after inflation, they simply cannot provide a sustainable retirement income!
The stock market on the other hand (measured by the S&P 500), has returned on average almost 6.5% after inflation. More than double the returns on bonds! And remember, these returns are average - as you can see on the chart, there were years of negative returns and bear markets sprinkled in this mix (and there always will be). But time is on your side if you stay invested – even as a retiree! This is why being invested in the stock market is ESSENTIAL for sustaining your income in retirement.
As always, we are here to help you with any questions you might have - whether you are just starting to think about retirement or are already there. You can contact us at email@example.com or give us a call.